A classic case of economic mismanagement

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A recent social media post caught my attention, where the author - who shall remain nameless - called for Egypt to use its international reserves to strengthen the pound and to improve liquidity in local markets. That a strong currency is necessarily good for an economy is a common misconception for many people. The use of foreign currency reserves is an even more abstract concept for the lay person.

When Egypt's reserves were around $33 billion, this was under 10% of GDP, which is one of the lowest ratios out of 43 emerging markets that I track. It is such a low reserves / GDP ratio, in fact, that it placed Egypt in the bottom 10th decile of that sample of countries on that metric:

These reserves have since been topped off, rising to $47 billion recently. While this recovery is welcome news for Egypt, it is still quite a small "bank balance" for such a large economy. And especially for one that relies significantly on food imports. Those reserves are a precious buffer for macro stability and shouldn't be used to buy pound assets for the central bank to facilitate private sector-driven dollar outflows from the country.

Moreover, Egypt needs to break the cycle of maintaining the pound at an overvalued exchange rate, only to keep having to devalue it, only because the previous round of devaluation hadn't been deep enough. Devaluation equates to macroeconomic balance for Egypt.

Thankfully for Egypt, the pound’s real exchange rate has decreased more over a three-year period than any other currency in the 43 countries I track. This really helps ease sovereign risk and is thanks in part to last year’s devaluation.

Yet, much like the improved reserves situation, the devaluation probably wasn’t deep enough, if the monster current account deficit is anything to by. At a projected -5.8% of GDP in 2025, this is one of largest such gaps in EM.

Overall, Egypt ranks as the fourth-riskiest country in my sample. The main culprits undermining Egypt’s sovereign risk profile are public debt-to-revenue and external public debt. At an eye-watering 518, public debt-to-revenue is higher in Egypt than anywhere else in my EM sample. Moreover, At nearly 32% of GDP, external public debt is in the top quintile (see table above).

My estimates suggest that public debt-to-revenue explains about 23% of Egypt’s likelihood of experiencing sovereign stress, while the external debt load accounts for some 17%.

Egypt is far from the median on virtually every indicator, suggesting policy volatility. Beyond the sky-high debt-to-revenue metric, low reserves, a large current account deficit, and a big, positive credit gap are also of concern, placing the country around the 90th risk percentile on those measures. Yet no country has done more than Egypt to rein in its REER dynamic, and annual general government debt growth is down sharply.

Despite securing IMF funding last year in exchange for the devaluation and commitments to policy reform, it appears that some of the old problems in Egypt’s economic policymaking framework persist. Make no mistake: the country is rated Caa1, B-, and B by the three main agencies, implying its substantial risks and highly speculative status as a sovereign credit.

Unfortunately, the model I use aligns well with the rating, suggesting that the country isn’t where it should be despite IMF support. Although annual growth has been exceeding 4% lately, inflation has climbed to 16%, and reserves have already begun to erode. I’m certain I’ve seen this movie before.

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